Mark Carney, the head of the Bank of Canada, speaks at a press conference after addressing the annual convention of the Canadian Auto Workers Union in Toronto on August 22, 2012. (Peter Power/The Globe and Mail)

Mark Carney, the head of the Bank of Canada, speaks at a press conference after addressing the annual convention of the Canadian Auto Workers Union in Toronto on August 22, 2012.(Peter Power/The Globe and Mail)

The Bank of Canada is putting the present threat of a crumbling global
economy ahead of a creeping worry that ultra-low interest rates are sowing the
seeds of the next financial crisis.

Mark Carney, the central bank’s governor, left the benchmark interest rate at
1 per cent Wednesday – now unchanged for two years – extending the longest
period of static interest rates since the mid-1950s.

Economy

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In a statement explaining the decision, the Bank of Canada indicated at least
slight concern that external headwinds could knock the country’s economy off
course. Some economists saw a pivot, arguing the central bank could be forced to
drop its stated intention to raise interest rates because doing so would hurt
exporters by putting upward pressure on the dollar.

For now, economic conditions are evolving “largely” as policy makers foresaw
at the time of their last forecast in July, and the central bank indicated for
the fourth time since April that it is inclined to increase borrowing costs as
soon as possible.

The Bank of Canada noted Wednesday that Canada’s household debt burden
continues to rise. That trend likely won’t change significantly until it becomes
more expensive to borrow, which is why Mr. Carney is trying to condition
Canadians to expect higher interest rates.

However, the Bank of Canada acknowledged that growth in China and other big
emerging market economies is “decelerating somewhat more quickly” than
anticipated. If that persists, Mr. Carney could be forced to alter course when
he and his advisers draw up a new outlook in October. Tepid economic growth in
the U.S. is offsetting a recession in much of Europe. That means near-term
prospects for the global economy rest with the China and countries like it.

“The only thing that can bring us a recession is the emerging markets and the
only thing that can bring us growth are emerging economies,” Denis Senécal, head
of fixed income and cash at State Street Global Advisors, said from
Montreal.

As a result, outlooks for Canadian interest rates are tied to forecasters’
predictions of where the global economy is headed.

Paul Ashworth, chief North America economist at Capital Economics in Toronto,
said Canada’s economic momentum has stalled and that the Bank of Canada could be
forced to cut the benchmark rate next year as the global economy continues to
deteriorate. Economists at Toronto-Dominion Bank see things differently. Jacques
Marcil told the bank’s clients in a note that the global economy should rebound
by early next year and predicted the central bank will lift borrowing costs by
the spring.

The Bay Street debate over Bank of Canada policy rarely considers a more
theoretical question: whether it’s a good idea to leave borrowing costs so low
for so long.

Last week, William White, the Canadian economist who correctly predicted that
the U.S. housing boom was a harbinger of trouble, published a new paper that
argues ultra-low interest rates risk a lengthy list of “unintended
consequences,” including stoking inflation, inflating new asset-price bubbles
and exacerbating income disparity.

“None of these ‘unintended consequences’ could be remotely described as
desirable,” wrote Mr. White, a former Bank of Canada and Bank for International
Settlements economist who currently advises the OECD. He said central banks
should stand down and turn the job of saving the recovery over to
governments.

Mr. White’s opinion carries weight in policy circles.

The potential for low interest rates to create a housing bubble explains why
the Bank of Canada has been preparing businesses, households and investors for
higher rates. “To the extent that the economic expansion continues and the
current excess supply in the economy is gradually absorbed, some modest
withdrawal of the present considerable monetary policy stimulus may become
appropriate,” the central bank said in its statement, repeating to the letter
language that was first introduced in April.

A slower global economy would delay that excess supply from being absorbed,
giving the central bank cause to refrain from boosting interest rates. Even
those who worry about the longer-term effects of ultra-low interest rates say
the Bank of Canada likely would back down from its threat of higher rates if
global demand evaporates further and commodity prices stumble.

“The Canadian economy is like a boat in the ocean,” said Darcy Briggs at
Franklin Templeton Investments in Calgary. “Our economic fortunes are dictated
by what’s going on in the rest of the world.”

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